A couple of days ago I wrote a quick post comparing Spain and the US after their recessions in 2007/2008 and the government responses. The post was based on the premise that the US government had engaged in active stimulus while the Spanish government had not. As Mark Sadowski pointed out in the comments section this was not correct; in fact, the Spanish government did engage in fiscal stimulus beginning in 2008.
So, what accounts for this discrepancy? Are we to assume that the US succeeded where Spain failed because of the QE program that the Fed undertook? I don’t think so. I think the explanation is far simpler and can be uncovered by looking in detail at the national accounts.
The first thing that we need to understand is the different structural make-up of each economy. We can do this by comparing how GDP is formed. The following graphs show to what extent GDP was weighted toward Final Consumption Expenditure and Gross Capital Formation — that is, toward consumption and investment. (All data is from the OECD and is expressed in constant prices).
The difference, as we can see, is rather striking. Throughout the period 2007-2008 the Spanish economy was far more reliant on investment than the US economy, which was substantially more consumption driven. Just prior to the recession in Spain consumption accounted for 76% of GDP while investment accounted for 29%. Meanwhile in the US just prior to the recession consumption accounted for 82% of GDP while investment accounted for 22%.
When we dig deeper into the data we find that key to this difference was the fact that housing construction (Dwellings) in Spain was a far more important component of GDP than was the case in the US. I have mapped their relative importance in the chart below. (Note that Spanish GDP peaked in 2008 while US GDP peaked in 2007 so I have taken each country at the pre-recession peak).
Again, the differences are striking. Just prior to the recession in Spain housing construction accounted for nearly 10.8% of GDP while in the US it only accounted for nearly 4.7%.
Now that we understand the relative structures of each economy it should be clear what happened during 2007-2008. As we can see from the chart below, housing construction fell from it’s pre-recession peak in both countries at fairly similar rate.
But as we have already shown the Spanish economy was far more reliant on this housing construction in the US. This, I think, is why the stimulus worked in the US while it did not work in Spain; simply put, the demand gap opened up by the bursting of the housing bubbles was far larger in Spain than in the US. Thus even if the Spanish government put a larger stimulus package in place it is not surprising that it failed where the US package succeeded.